Note: With this article, Minyanville is proud to welcome Phil Erlanger as its newest contributor. Phil brings a wealth of technically oriented insight and a unique approach to the 'Ville. We trust you will quickly see the benefit of his work and we look forward to hearing more from him.
Hello Minyanville! First, I would like to extend my thanks to Todd, Greg, and the Professors for inviting me on board.
Secondly, I thought I would explain the Erlanger methodology, and to give you some insight as to what you will see from us in the future.
Erlanger Research is all about squeeze plays. It is essentially a 2 factor model - sentiment and price action. We look for big, established bets that the market is moving against. So, the first factor is to determine some fat, juicy bet (either long or short.) A recent one that comes to mind is Continental Airlines (NYSE: CAL):
In November 2003, the short ratio for CAL was light. This was due to an 8-month advance as short positions that peaked in March 2003 ran for cover. Price for CAL entered 2004 in downtrend status, exacerbated by the historic rise in the price of oil. Negative bets in the way of short selling expanded throughout this year, culminating in a heavy short ratio of 7.53 in October 2004.
The second factor we look for in a squeeze play is price action. How is the market treating that big short position in CAL? What is the seasonal tendency for its price trend on a yearly basis? A majority can be correct for a period of time. Rather than guess, hope or speculate that they are wrong, our approach is to wait for the market to tell us that a majority is wrong by moving against their interests - opposite the direction they bet on so heavily. In the above chart, price has already turned northerly.
Our Power ranking combines our relative strength ranking (we call this our Technical Rank) and our Short Intensity ranking. On a scale of 0% to 100%, the higher the Power Rank, the stronger price is advancing against a larger than normal group of short sellers. The current 92% Power Rank indicates a major short squeeze underway. It was also important to note the upturn in industry group seasonality in October:
We have a standard caveat regarding seasonality. Seasonal cycles do not cause market moves, they simply reflect tendencies during certain periods. The idea is to observe how well, or how poorly, price reflects a seasonal cycle. In the chart above, the statistic "2004 r = 0.40" tells us how correlated this year's trading is to the cycle (in this case this cycle was comprised of the action of the prior 8 years.) A value of 1 would be perfect correlation (never happens), a value of 0 means there is no correlation, and -1 is a perfectly inverse correlation. If this chart were observed in June, the correlation would not be so high because the airline stocks did poorly during a positive seasonal period - a real good clue that it would really do poorly in the next seasonal downturn (July to October.) October through November is a positive seasonal period for airline stocks, and thus a positive indication for the price action side of our 2 factor model.
We rank 18 sectors and 139 industry groups based upon the average Power Rank of their component issues. Therefore, these are non-capitalized group and sector rankings. The latest sector rankings are as follows:
Surprise, surprise, those pesky airline stocks have flown the transports to our number 1 sector ranking.
At first brush, a 2 factor model such as this might appear oversimplified. To that we would pose a question:
How many patterns must one be able to recognize and interpret in a 10 factor model, where each factor can be determined in one of five ways: very positive, positive, neutral, negative or very negative?
First one with the correct answer gets a Minyanville T-Shirt of their choice!!! E-mails to: email@example.com
We will be commenting heavily on groups and sectors, and offer insights into headline issues. We will get new monthly NYSE & Amex short interest after the November 19th close and then NASDAQ data after the 26th. We will touch base after the short numbers come out. In the meantime questions and comments can be sent to firstname.lastname@example.org.
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